What to do with an old company pension?

[MyNameIsUrl]

A relative has a pension plan from an employment he left in about 1985. Although there have never been annual statements, he asked for a retirement statement in 2018, took no action, and then asked for another last year.

The retirement statements are of the form:
Option 1: Pension paid from the Plan, no tax-free cash
Option 2: Pension paid from the Plan, with maximum tax-free cash
Option 3: Lower tax-free cash and reduced pension
Option 4: Options to transfer your benefits out of the Plan

The first three options have £ values shown, but the fourth doesn’t, so both times he’s followed up with a request for what the amount would be if he were to pursue Option 4 and transfer out of the Plan. This last year, instead of the value being up substantially (in line with global markets over the last 5 years) he was dismayed to find it had dropped over 20%.

We’d both always thought the scheme was defined contribution, and that it might be a sensible option to transfer the pot to his existing SIPP. He went back to ask about the drop in value and to clarify what his money is invested in that has performed so poorly. The covering email from the administrators mentions this is an ‘occupational, final salary arrangement’ which was surprising news. Closer examination of the documentation shows there is no clarification whether the Plan is DC or DB, so it seems like we were just making a wrong assumption for many years.

The pension company have provided an explanation why the value has dropped and I understand the explanation – expected long-term interest rates have increased and this acts to reduce the transfer value. The annual pension amount quoted in option 1 is about 5.5% of the transfer value, which to me sounds roughly what might be expected.

It’s probably an impossible question to ask which option is best - I suppose the issue can really only be resolved by my relative deciding if he will sleep better at night with a big lump sum in his SIPP, or with a guaranteed monthly income for life (plus widow’s pension). That is probably a decision made with the heart rather than the head.

More specific questions:
If he decides on an annuity, presumably he doesn’t need to take it from the current pension company? Would he just use the transfer value to get quotes from other providers?
If decides to transfer into his SIPP based on the transfer value given, are there likely to be restrictions on this or can he just ask his SIPP provider to effect the transfer?

[XFool]

A relative has a pension plan from an employment he left in about 1985. Although there have never been annual statements, he asked for a retirement statement in 2018, took no action, and then asked for another last year.

The retirement statements are of the form:
Option 1: Pension paid from the Plan, no tax-free cash
Option 2: Pension paid from the Plan, with maximum tax-free cash
Option 3: Lower tax-free cash and reduced pension
Option 4: Options to transfer your benefits out of the Plan

The first three options have £ values shown, but the fourth doesn’t, so both times he’s followed up with a request for what the amount would be if he were to pursue Option 4 and transfer out of the Plan. This last year, instead of the value being up substantially (in line with global markets over the last 5 years) he was dismayed to find it had dropped over 20%.

We’d both always thought the scheme was defined contribution, and that it might be a sensible option to transfer the pot to his existing SIPP. He went back to ask about the drop in value and to clarify what his money is invested in that has performed so poorly. The covering email from the administrators mentions this is an ‘occupational, final salary arrangement’ which was surprising news. Closer examination of the documentation shows there is no clarification whether the Plan is DC or DB, so it seems like we were just making a wrong assumption for many years.
...
More specific questions:
If he decides on an annuity, presumably he doesn’t need to take it from the current pension company?

If it is indeed a Defined Benefit Pension, there will be, AFAIK, no "annuity" option from the current company. If there is an annuity option from the present company then it is unlikely to be a Defined Benefit pension. Transfer options would be: In specie (service years) to another DB company scheme, or a transfer value to another pension scheme, whether a DB scheme or other.

[Urbandreamer]

The pension company have provided an explanation why the value has dropped and I understand the explanation – expected long-term interest rates have increased and this acts to reduce the transfer value. The annual pension amount quoted in option 1 is about 5.5% of the transfer value, which to me sounds roughly what might be expected.

It’s probably an impossible question to ask which option is best - I suppose the issue can really only be resolved by my relative deciding if he will sleep better at night with a big lump sum in his SIPP, or with a guaranteed monthly income for life (plus widow’s pension). That is probably a decision made with the heart rather than the head.

More specific questions:
If he decides on an annuity, presumably he doesn’t need to take it from the current pension company? Would he just use the transfer value to get quotes from other providers?
If decides to transfer into his SIPP based on the transfer value given, are there likely to be restrictions on this or can he just ask his SIPP provider to effect the transfer?

I think that you are very confused as to the difference between a DB, DC and an annuity.
A DB scheme provides an income based upon final salary. It's not an annuity. Usually this income is inflation linked.
A DC is a pot of money. You can use this to generate an income, take the capital or spend it upon an annuity.

An annuity is a contract, usually with an insurance company, to provide an annual income. The income depends upon many things but at heart depends upon the capital that you give them and how much they expect to have to pay out.

Ok, to cut to the chase, while financial advice would be a really good idea, it's likely that it's a legal requirement that he seeks it, unless the pension remains where it is. Exemptions from the legal requirement are "small pot" pensions (less than £30k transfer value).
https://www.gov.uk/hmrc-internal-manual ... l-lump-sum

[MyNameIsUrl]

I think that you are very confused as to the difference between a DB, DC and an annuity.
A DB scheme provides an income based upon final salary. It's not an annuity. Usually this income is inflation linked.
A DC is a pot of money. You can use this to generate an income, take the capital or spend it upon an annuity.

An annuity is a contract, usually with an insurance company, to provide an annual income. The income depends upon many things but at heart depends upon the capital that you give them and how much they expect to have to pay out.

Ok, to cut to the chase, while financial advice would be a really good idea, it's likely that it's a legal requirement that he seeks it, unless the pension remains where it is. Exemptions from the legal requirement are "small pot" pensions (less than £30k transfer value).
https://www.gov.uk/hmrc-internal-manual ... l-lump-sum

Thanks, that’s helpful. A DB provides an income, a DC may be used to purchase an annuity: in my ignorance I had thought these two were the same thing, but they’re not. I’d vaguely heard of shopping around for the best annuity but that’s not what’s happening here with this ‘final salary’ DB pension.

As the value is substantially greater than 30k transfer value it seems his options are rather limited, namely to take an income, possibly with a lump sum which he has some discretion over. He won’t have the broad range of options that are offered with annuities, and he would find it difficult to transfer out to his SIPP.

[DrFfybes]

As the value is substantially greater than 30k transfer value it seems his options are rather limited, namely to take an income, possibly with a lump sum which he has some discretion over. He won’t have the broad range of options that are offered with annuities, and he would find it difficult to transfer out to his SIPP.

It is very unlikely an advisor would suggest transferring out, unless there were some life limiting illness and he wished to make use of some IHT loopholes inthe next 12 months.

Generally DB schemes are much more generous than DC ones, and the benefits offered would cost far more than the transfer value if a similar annuity was purchased. They are usually index linked in payment (sometimes with a cap) and with a spousal pension attached. You can also often take them early subject to a reduction, typically 3-5% less for every year taken. Depending upon their tax position taking it early can be a good idea, the breakeven point for the reduction tends to be about age 84 after which you are worse off, but if you don't pay tax on it at the moment but will after state Pension age then the effective reduction is less. I took one last year for this reason.

We have DB pensions which cover our basic outgoings, this means we can/could be far more adventurous with our investment strategy, which in the last decade of low interest rates and high equity returns has been very beneficial. The decision regarding the amount of lump sum depends on your relative's requirements, but also the multiple applied in the reduction of the pension.

Eg if they lose £50pa in pension for each £1k of lump sum then that requires a 5% return to cover if the lump sum is invested elsewhere. But often the multiple is different and the reduction in annual pension can be higher. Obviously their need for cash or income will govern their decision.

Paul

[mc2fool]

As indexation (inflation linking for pensions in payment) has been mentioned a couple of times, the OP & their relative should note that there is no statutory requirement for indexation in payment for pension rights accrued prior to 1997.

Of course, it's possible that the company's scheme may be generous and provide indexation for pre-1997 rights even though they don't legally have to. I'd recommend checking the scheme documents or (formally) asking the scheme providers.

It should also be noted that there is no statutory requirement for revaluation (increases in deferment) for pension rights accrued prior to 1986. Although as the transfer value is over £30K even though the OP's relative stopped being an active member in 1985, it looks likely that the scheme has provided some revaluation, even though they don't legally have to.

[MyNameIsUrl]

Eg if they lose £50pa in pension for each £1k of lump sum then that requires a 5% return to cover if the lump sum is invested elsewhere. But often the multiple is different and the reduction in annual pension can be higher. Obviously their need for cash or income will govern their decision.

Interesting. I've looked at the figures and the loss in pension for additional lump sum would require a return of 6.3%, except that the lump sum is tax free and the pension would be taxed at basic rate, so the required return is 5%. The two cashflows would be equal after 20 years. As you say, the decision will be based on his need for cash or income rather than an objective 'best' choice. It does seem though, that the option to take 100% of the value into his SIPP isn't open to him.